Issuers Should Believe…and Have a Reason to Believe

Issuers Should Believe…and Have a Reason to Believe

In a recent case involving a company called Omnicare, the U.S. Supreme Court made its first significant analysis of liability for opinions expressed by an issuer of securities in a public offering. Such expressions of opinion are a wheeze frequently resorted to by issuers and the deal team’s lawyers when the issuer wants to make a statement in its prospectus about some aspect of its business, but the statement may be difficult for the lawyers to substantiate sufficiently. (Anyone who has reviewed even a small number of prospectuses will have noticed the frequent use of “we believe…” in describing issuers’ invariably leading positions in their respective industries). A précis follows:

The Court emphasised the importance of the context in which an issuer’s opinion is made and how it would be viewed by a “reasonable investor” (i.e., an objective standard that is frequently used in common law legal systems); such opinions are not viewed in isolation from other disclosure given in the prospectus to investors.

With respect to liability for misstatements of material facts, liability is limited to factual statements (not to validity of the opinion itself), and does not allow investors to second-guess inherently subjective and uncertain assessments in opinions by the issuer.

With respect to liability for omissions of material facts, the opinion should fairly align with the information in the issuer’s possession at the time it expressed the opinion; essentially there could be liability if the opinion is based on no facts or on flimsy facts.

(By way of explanatory background, Section 11 of the U.S. Securities Act of 1933 gives purchasers of securities in public offerings in the U.S. a right to bring a lawsuit against either the issuer of the securities or designated individuals (for example, the issuer’s directors and partners, the underwriters of the securities offering, and so forth) for (1) misstatements of material fact (referred to below as the “misstatement clause”), and (2) omissions to state material facts (referred to below as the “omissions clause”) in the issuer’s registration statement for the offering. The registration statement contains the prospectus (where material misstatements or omissions would normally be found) used to sell the securities to the public. There is strict liability on the issuer’s part for material misstatements and omissions, and in either case the buyer need not prove (as he must to establish certain other securities offences) that the defendant issuer acted with any intent to deceive or defraud.)

Two sentences in Omnicare’s prospectus expressed Omnicare’s view of its compliance with legal requirements:

“We believe our contract arrangements with other healthcare providers, our pharmaceutical suppliers and our pharmacy practices are in compliance with applicable federal and state laws.”

“We believe that our contracts with pharmaceutical manufacturers are legally and economically valid arrangements that bring value to the healthcare system and the patients that we serve.”

On the same page as the first opinion above, Omnicare mentioned several state-initiated “enforcement actions against pharmaceutical manufacturers” for offering payments to pharmacies that dispensed their products (in some social circles where the norms of discourse are less refined, this is sometimes referred to as “bribery”, as though it were a tawdry practice); the prospectus then cautioned that the laws relating to that practice might “be interpreted in the future in a manner inconsistent with our interpretation and application” (which is how disclosure lawyers say “don’t say we didn’t warn you”). Omnicare also noted in its prospectus that the U.S. Federal government had expressed “significant concerns” about some manufacturers’ rebates to pharmacies and warned that business might suffer “if these price concessions were no longer provided.”

Pension funds purchased Omnicare’s shares in the public offering, and then brought suit alleging that Omnicare’s two opinions about its legal compliance gave rise to strict liability under Section 11 when Omnicare’s opinions turned out to have been erroneously held. Referring to lawsuits that the U.S. Federal government had brought against Omnicare after the prospectus, the pension funds’ complaint stated that Omnicare’s receipt of payments from drug manufacturers violated anti-kickback laws. At the same time, the pension funds made clear that in light of Section 11’s strict liability standard for issuers of securities, the pension funds chose to “exclude and disclaim any allegation that could be construed as alleging fraud or intentional or reckless misconduct” (it is a technical point, but it turns out to be important below).

The appeals court for the Sixth Circuit had held that the pension funds had to allege only that the opinion was “objectively false”; they did not need to contend that anyone at Omnicare “disbelieved [the opinion] at the time it was expressed.”

The pension funds had argued at the appeals court that expressing an opinion is tantamount to warranting the matter discussed in the opinion. The Court noted that difference between fact and opinion “is so ingrained in our everyday ways of speaking and thinking as to make resort to old dictionaries seem a mite silly”. The Court rejected strict liability for expressing an opinion that turned out to have been mistaken, noting that liability under Section 11 is limited to facts, and investors cannot second-guess inherently subjective and uncertain assessments. The Court did agree that Section 11’s misstatement clause applies to (1) the fact of whether or not the opinion is held by the person expressing the opinion and (2) factual statements contained within expressions of opinion to support the opinion, if those factual statements themselves are untrue.

In reaching its decision on the expression of opinion, the Supreme Court noted that the pension funds did not contest that Omnicare’s opinion was honestly held. Recall above that the pension funds’ complaint explicitly “exclude[s] and disclaim[s]” any allegation sounding in fraud or deception; this means the pension funds were relying on strict liability of the issuer.

However the pension funds also asserted that Omnicare’s opinions omitted relevant, material facts that therefore made the opinion misleading. Prior cases have established that whether a statement is “misleading” or not depends on the perspective of a “reasonable investor”. The enquiry (like the one into materiality) is objective. The securities laws care only about the “significance of an omitted or misrepresented fact to a reasonable investor”. Reasonable investors understand such statements are not guarantees, and Section 11’s omissions clause therefore does not treat them that way.

The Court did note that a reasonable investor may, depending on the circumstances, understand an opinion to convey facts about how the speaker has formed the opinion. In the context of the securities market, an investor, though recognising that opinions can prove to have been wrongly held, still likely expects such an opinion to be based on some meaningful legal enquiry—rather than, say, on mere intuition. The reasonable investor expects not just that the issuer believes the opinion, but that the opinion is supported by the balance of information in the issuer’s possession at the time. Thus, if a registration statement omits material facts about the issuer’s enquiry into or knowledge concerning a statement of opinion, and if those facts conflict with what a reasonable investor would take from the statement itself, then Section 11’s omissions clause creates liability.

In contrast, the Court stated that an opinion is not necessarily misleading when an issuer knows, but fails to disclose, some fact that is inconsistent with the opinion (for example, one junior professional adviser dissenting from the opinion of several senior professional advisers). Reasonable investors understand that opinions sometimes rest on a weighing of competing facts; indeed, the presence of such facts is one reason why an issuer may frame a statement as an opinion, thus conveying uncertainty. A reasonable investor does not expect that every fact known to an issuer supports its opinion.

The reasonable investor understands a statement of opinion in its full context, and Section 11 creates liability only for the omission of material facts that are inconsistent with such a fair reading. These principles inhere in much common law respecting the tort of misrepresentation. Quoting Prosser and Keeton on the Law of Torts (the leading treatise on torts), the Court explained that “it has been recognised very often that the expression of an opinion may carry with it an implied assertion, not only that the speaker knows no facts which would preclude such an opinion, but that he does know facts which justify it.” That is especially (and traditionally) the case, the treatise continues, where—as in a registration statement—a speaker “holds himself out or is understood as having special knowledge of the matter which is not available to the plaintiff.” Literal accuracy is not enough: an issuer must as well desist from misleading investors by saying one thing and holding back another.

In order to successfully bring a lawsuit against the issuer of securities, the investor must identify particular (and material) facts going to the basis for the issuer’s opinion—facts about the enquiry the issuer did or did not conduct or the knowledge it did or did not have—whose omission makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context.

The Supreme Court sent the Omnicare case back to the lower courts for decision, noting that the pension funds could not proceed without identifying one or more facts left out of Omnicare’s registration statement. If the pension funds can identify such omitted facts, the lower court must determine whether the omitted fact would have been material to a reasonable investor—i.e., whether “there is a substantial likelihood that a reasonable [investor] would consider it important.” Assuming the pension funds clear those hurdles, the lower court must ask whether the alleged omission rendered Omnicare’s legal compliance opinions misleading in the way described earlier—i.e., because the excluded fact shows that Omnicare lacked the basis for making those statements that a reasonable investor would expect.